General Anti Avoidance Rules (GAAR): Principles, implications and its Procedure
What is GAAR?
GAAR (General Anti-Avoidance Rules) is a tool for checking aggressive tax planning especially that transaction or business arrangement which is/are entered into with the objective of avoiding tax. It has been introduced in India because of VODAFONE case ruling in favour of this company by the Supreme Court.
For example: “A” makes a company XYZ to sell product C. The company B pays 35% tax, but if “A” himself sold the products he would pay 40% tax. “A” has formed the company only to save 5% tax.
Australia introduced such rules way back in 1981. Later on countries like Germany, France, Canada, New Zealand, South Africa etc too adopted GAAR. However, countries like USA and UK have adopted a cautious approach and have not been aggressive in this regard.
Before moving on to the discussion on GAAR, firstly we know that “What is the difference between tax avoidance and tax evasion”.
How GAAR work?
The provision of GAAR is to codify the doctrine of ‘substance over form’ where the real intention of the parties and purpose of an arrangement is taken into account for determining the tax consequences, irrespective of the legal structure of the concerned transaction or arrangement. It essentially comes into effect where an arrangement is entered into with the main purpose or one of the main purposes of obtaining a tax benefit and which also satisfies at least one of the following four tests:
(1). The arrangement creates rights and obligations that are not at arm’s length,
(2). It results in misuse or abuse of provisions of tax laws,
(3). Lacks commercial substance or is deemed to lack commercial substance, or
(4). It is not carried out in a bona fide manner.
Hence we can say, if the tax officer believes that the main purpose or one of the main purposes of an arrangement is to obtain a tax benefit and even if one of the above four tests are satisfied, he has powers to declare it as an impermissible avoidance arrangement and re-characterise the entire transaction in a manner that is more conducive to maximising tax revenues. There are many troubling aspects of this provision that will make doing business in India even more challenging, than what it already is from a tax perspective –
(1). It is presumed that obtaining tax benefit is the main purpose of the arrangement unless otherwise proved by the taxpayer. This is an onerous burden that under a fair rule of law should be discharged by revenue collector and not the taxpayer.
(2). An arrangement will be deemed to lack commercial substance under GAAR if it involves the location of an asset or of a transaction or of the place of residence of any party that would not have been so located for any substantial commercial purpose other than obtaining tax benefit.
(3). GAAR allows tax authorities to call a business arrangement or a transaction ‘impermissible avoidance arrangement’ if they feel it has been primarily entered into to avoid taxes. Once an arrangement is ruled ‘impermissible’ then the tax authorities can deny tax benefits. Most aggressive tax avoidance arrangements would be under the risk of being termed impermissible.
(4). GAAR is a very broad based provision and can easily be applied to most tax-saving arrangements. Many experts feel that the provision would give unbridled powers to tax officers, allowing them to question any tax saving deal. Foreign institutional investors are worried that their investments routed through Mauritius could be denied tax benefits enjoyed by them under the Indo-Mauritius Tax Treaty.
P. Shome Panel Recommendations-
(1).The Shome Committee has recommended the postponement of the controversial tax provision by three years to 2016-17. In effect, GAAR would apply from assessment year 2017-18. GAAR was aimed at firms and investors routing money through tax havens.
(2).The committee has recommended that GAAR be applicable only if the monetary threshold of tax benefit is Rs 3 crore and more. The draft report has sought comments from the stake holders by September 15.
(3).The Committee has recommended abolition of capital gains tax on sale of listed securities by both resident and non-resident investors. Currently, there are no long-term capital gains on listed securities in India while short-term gains are taxed at 10-30 per cent depending on the class of investors
(4).The panel has suggested an increase in securities transaction tax (STT) to make good the tax revenue loss that may arise from abolition of tax on gains from transfer of listed securities.
(5). As a step towards reassuring global investors, the Committee in its draft report suggested that GAAR provisions should not be invoked to examine the genuineness of the residency of entities in Mauritius. Mauritius is the most preferred route for foreign investments because of the liberal taxation regime in the island country. India has a double taxation avoidance treaty with Mauritius.
(6).The "investment climate in the country has suffered (a) serious setback and investors' confidence has been hit mainly because of the concerns over the impact of retrospective tax laws and GAAR.
(7).The panel wrote in a report posted on the Finance Ministry website, suggesting the government does not begin enforcing the rules until 2016-17 because "GAAR is an extremely advanced instrument of tax administration -- one of deterrence, rather than for revenue generation.
(8).The general anti-avoidance rules (GAAR), first proposed in the budget in March, was meant to target tax evaders, partly by stopping Indian companies and investors from routing investments through Mauritius or other tax havens for the sole purpose of avoiding taxes.
What was the Basic Criticism of GAAR? Why GAAR is dreaded?
Many provisions of GAAR have been criticised by various thinkers. However, the basic criticism of GAAR provisions is that it is considered to be too harsh in nature and there was a fear (considering poor record of IT authorities in India) that tax authorities will apply these provisions regularly (or read misuse) and torture the general honest tax payer too.
Two Examples to Understand GAAR provisions: (Source GAAR Committee)
Case A: A business sets up an undertaking in an under developed area by putting in substantial investment of capital, carries out manufacturing activities therein and claims a tax deduction on sale of such production/manufacturing. Is GAAR applicable in this case?
Explanation: There is an arrangement and one of the main purposes is a tax benefit. However, this is a case of tax mitigation where the tax payer is taking advantage of a fiscal incentive offered to him by submitting to the conditions and economic consequences of the provisions in the legislation e.g., setting up the business only in the under developed area. Revenue would not invoke GAAR as regards this arrangement.
Case B: A business sets up a factory for manufacturing in an under developed tax exempt area. It then diverts its production from other connected manufacturing units and shows the same as manufactured in the tax exempt unit (while doing only process of packaging there). Is GAAR applicable in this case?
Explanation: There is an arrangement and there is a tax benefit, the main purpose or one of the main purposes of this arrangement is to obtain a tax benefit. The transaction misses commercial nature and there is misuse of the tax provisions. Revenue would invoke GAAR as regards this arrangement.